Global Tax Alert. El Salvador proposes tax reform. Amendments to the Tax Code. News from Americas Tax Center

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1 30 May 2014 Global Tax Alert News from Americas Tax Center EY Americas Tax Center The EY Americas Tax Center brings together the experience and perspectives of over 10,000 tax professionals across the region to help clients address administrative, legislative and regulatory opportunities and challenges in the 33 countries that comprise the Americas region of the global EY organization. Copy into your web browser: Services/Tax/Americas-Tax- Center---borderless-clientservice El Salvador proposes tax reform On 15 May 2014, El Salvador s Treasury Ministry sent four tax reform bills (the Tax Reform) to Congress for discussion. This Tax Reform introduces a number of important amendments to the current tax laws and regulations and also creates new taxes. Amendments to the Tax Code Transfer pricing A specific reference would be made in Section 62-A of the Tax Code to the methods established by the Organisation of Economic Co-operation and Development (OECD) to determine the pricing used in related-party transactions. This express reference to the OECD Transfer Pricing Guidelines in the Tax Code would give comfort to taxpayers and resolve the current uncertainty around their use, which is merely mentioned in the Administrative Guideline 1 of the Salvadoran Treasury. As a result of this change, taxpayers could carry out their transfer pricing analyses in accordance with OECD Guidelines and it would be binding upon the tax authorities. Rules for period during which tax authorities can make audits and assessments 2 The computation of the maximum time for the tax authorities to exercise their audit and assessment powers would be suspended from the date of notice of the auditor appointment order until the date when the taxpayer is notified of the evidence hearing. 3 Such evidence hearing takes place immediately after a taxpayer is provided with a tax assessment. This represents a significant change, as the tax authorities currently have to complete their tax audits and make their corresponding assessments within the applicable statute of limitations in order to not be time-barred. With the reform, the tax authorities would be entitled to carry out tax audits without any time limitation by merely giving notice to a taxpayer that it will be subject to a tax audit.

2 Rules for the suspension of the running of the statute of limitations for tax collection The statute of limitations applicable to the tax authorities to collect taxes would be suspended from the time a taxpayer initiates an administrative or judicial proceeding until the disputed issue is finally settled by judicial decision. This also represents a significant change, as the only event currently suspending the running of the statute of limitations for tax collection purposes is when a collection notice is served to the taxpayer. Tax solvency certificates 4 Taxpayers that challenge a tax assessment before the Administrative Court of Appeals of the Supreme Court of Justice 5 can currently request a suspension of such assessment, including the payment request attached to it, and they do not have to provide a guarantee to secure the payment. The reform would not allow a payment suspension. Rather, it would require taxpayers with taxes assessed by the tax authorities to provide a guarantee for the payment while the taxpayer is challenging the tax authorities position in court. Failure to provide a guarantee would cause a taxpayer to be treated as insolvent in the tax solvency certificates issued by the tax authorities. Delinquent taxpayer s disclosure The tax authorities would be authorized to publish in two national newspapers and on the Treasury s website abstracts of: (i) tax assessments, 6 (ii) judgments rendered by the Court of Appeals for Internal Taxes and Customs, 7 and (iii) judgments of the Supreme Court of Justice 8 irrespective of the fact that taxpayers can still challenge in court the tax authorities position for items (i) and (ii). The disclosure would include the taxpayer s name, the amount of the assessment and its cause. Control over equipment, devices or computer systems used for payments Electronic devices (e.g., point-of-sale terminals) used for the payments of goods or services, which are currently not regulated for tax purposes, would have to include a specific identification assigned by the tax authorities in accordance with regulations to be issued by them. Taxpayers would generally be allowed to use only those electronic devices to comply with the regulations. Additionally, receipts issued by those electronic devices would have to include an authorized identification number given by the tax authorities. Introduction of an Alternative Minimum Income Tax on net assets The Tax Reform proposes the introduction of an Alternative Minimum Tax (AMT) 9 to the income tax law. The AMT is a minimum income tax computed by applying a rate of 1% to a taxpayer s net assets. Income tax would be computed by applying the standard corporate income tax rate of 30% to net income and applying the AMT to net assets. The income tax that must be paid would be the higher amount resulting from the computations. Computation of net asset value The net asset value would be determined by subtracting from the total value of the assets accumulated: (1) depreciations and amortizations, (2) non-operating fixed assets, (3) assets owned that are located abroad, (4) shares owned in other Salvadoran entities, and (5) the balance of financial liabilities related to fixed operating assets. Assets used in agriculture and cattle, but excluding agroindustry, would also be deducted from the total asset value. Exemptions Several types of taxpayers would be exempt from the AMT, including the following: Users of industrial and commercialization free trade zones Users of the inward processing regime Shared services centers Entities and trusts financed by the state of El Salvador International organizations Taxpayers that initiate business operations for their first three tax years of activity, provided such activity is carried out with new investments Taxpayers with taxable income equal to or less than $150,000 2 Global Tax Alert Americas Tax Center

3 Introduction of a tax on certain financial transactions The Tax Reform proposes: (i) a tax on certain financial transactions, and (ii) a special withholding on certain transactions carried out in cash. A tax of 0.25% would apply to payments in El Salvador in excess of $750 made by check or wire transfers The 0.25% tax would apply to debits to checking accounts and payment orders or wire transfers corresponding to: Payments for goods and services by check and debit card for which the transaction value exceeds $750 Payments via wire transfers for which the transaction value exceeds $750 Transfers in favor of third parties, in any form or by any technological means, for which the transaction value exceeds $750 Loan disbursements of any kind (exceptions apply) Transactions between financial institutions for their own purposes or in accordance with a client s instructions Several types of transactions would be exempt from the tax, including the following: Cash withdrawn from checking accounts at automated teller machines or in branches of financial institutions Payments made with credit cards Social security payments Payments and transfers made by users of free trade zones, users of the inward processing regime and shared services centers Payments of employment income, including related indemnifications made by wire transfer or check Reimbursements of loans by clients of financial institutions (exemption does not apply to loans originating abroad) Loan disbursements used for the working capital of very small businesses, for the purchase of homes, or for agriculture or cattle, provided the disbursements are in aggregate equal to or less than $50,000 Transfers between an account holder s checking accounts The financial institutions would be withholding agents of this tax and would be jointly and severally liable for its payment. 0.25% withholding on cash deposits, payments and withdrawals over $5,000 The Tax Reform would also impose a 0.25% withholding tax that would apply to deposits, payments and cash withdrawals exceeding $5,000 per transaction or in aggregate on a monthly basis. Taxpayers would make those deposits, payments or cash withdrawals, while financial institutions would act as withholding agents. Users of free trade zones, users of the inward processing regime and shared services centers would be exempt from this withholding. The taxes withheld would be creditable against any tax administered by the tax authorities within two years of the withholding date. Introduction of a luxury real estate tax The Tax Reform proposes the introduction of a luxury real estate tax on the ownership of certain types of real estate located in El Salvador. This tax would apply to: Urban or rural residential property, as well as undeveloped urban land, with a value exceeding $350,000 on an individual or aggregate basis Developed property as a result of a project authorized under the Zoning and Construction Law 10 Real estate for recreational use, with or without constructions, or in the process of being developed, irrespective of the location or value thereof, including homes, lots of land, country houses located on beaches, by lakes, in mountains or in the city The tax would be triggered by the ownership of the real estate mentioned above on 31 December of each year. It would amount to 1% of the tax value of the property, to be computed in accordance with the valuation criteria set out in the law. The tax return would have to be filed and the corresponding tax paid within the first four months of each year. Several types of real property would be exempt from this tax, including the following: Global Tax Alert Americas Tax Center 3

4 Urban or rural residential property, as well as undeveloped urban land, with a value equal to or less than $350,000 on an individual or aggregate basis Real estate property used for a business purpose in agricultural, industrial, commercial, services or financial activities with the exception of developed property as a result of a project authorized under the Zoning and Construction Law 11 Real estate property that belongs to the state, public authorities, municipalities Real estate property that belongs to non-profit or International organizations Endnotes 1. In Spanish: Guía de Orientación No. 001/2012, which is intended to provide general guidance to taxpayers on the tax treatment of related-party transactions or transactions with entities domiciled in tax havens. The purpose of this Administrative Guideline is to supplement the Tax Code by defining guidelines for both taxpayers and tax auditors, but it does not constitute positive and enforceable law. 2. The tax authorities have three years to assess additional taxes due as of the date the relevant return was due, or five years when no return has been filed. 3. In Spanish: audiencia y apertura a pruebas. 4. Tax solvency certificates in tax matters are issued by the tax authorities and can be required in El Salvador in a number of circumstances, e.g., to participate in a public tender. The purpose of the certificate is to state whether a given taxpayer is current with its tax obligations. Taxpayers are categorized as: (i) solvent, (ii) insolvent, or (iii) authorized (i.e., the taxpayer has submitted a guarantee to secure the payment of taxes requested by the tax authorities assessment). 5. In Spanish: Sala de lo Contencioso Administrativo. 6. Corresponds to the first phase of the administrative part of the tax procedure. 7. In Spanish: Tribunal de Apelaciones de los Impuestos Internos y de Aduanas, which corresponds to the second phase of the administrative part of the tax procedure. 8. The judicial part of the tax procedure in which the case is finally settled by the Supreme Court of Justice. 9. Note that there was an AMT in place in El Salvador based on gross income. The previous AMT statutory scheme was declared unconstitutional by the Supreme Court of Justice on 15 November 2013, on the grounds that it violated the constitutional principles of tax fairness and ability-to-pay by not allowing taxpayers to take any deductions on costs and expenses necessary to generate taxable income or to protect the source thereof. 10. In Spanish: Ley de Urbanismo y Construcción. 11. In Spanish: Ley de Urbanismo y Construcción. 4 Global Tax Alert Americas Tax Center

5 For additional information with respect to this Alert, please contact the following: Ernst & Young, S.A., San Salvador Carlos Gaitán Jesús Guzmán Héctor Mancia Ernst & Young, S.A., San José, Costa Rica Alexandre Barbellion Rafael Sayagues Ernst & Young Limited Corp., Panama City Luis Eduardo Ocando María José Luna Global Tax Alert Americas Tax Center 5

6 EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. Americas Tax Center 2014 EYGM Limited. All Rights Reserved. EYG No. CM4457 This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. ey.com